Indonesia poised for a pullback

In recent months, one of the most volatile currencies has been the rupiah, thanks to domestic political developments.

A reflection of a trader on a monitor
Source: Bloomberg

The Indonesian currency and local stocks have rallied over the past year amid the twist and turns ahead of July’s presidential elections.

By the time market favourite Joko ‘Jokowi’ Widodo was announced the winner ahead of Prabowo Subianto, USD/IDR jumped 5% and Jakarta Composite had risen 19% year-to-date.

At a glance, it looks like Indonesia could easily continue the momentum and build on its growing attractiveness as an investment destination.

The likes of General Electric, Foxconn and Toyota have all recently reported to be setting up production bases, due to cost-efficiencies.

Despite the positive headlines, there are rising concerns that the rupiah and local stocks have started to become overbought.

Firstly in the short term, markets are likely to head into at least a month of uncertainty, as investor sentiment gets weighed down by Prabowo’s challenge of the election results. The constitutional court is expected to make its decision in late-August, but even then the process could be dragged out if the verdict gets scrutinised further.

Secondly in the longer term, assuming Jokowi holds on to leadership, he is likely to face strong opposition in parliament, pushing through reforms.

He will also be taking over an economy, whose fundamentals continue to soften. Amid weakening commodity prices, Jokowi will face the challenge of weaning the country’s dependency on exports to China and cutting costly subsidies such as for fuel.

In brief, the economy hasn’t improved much from its pre-election state.  Once the post-election euphoria wears off, we could see investors starting to get more sceptical, especially if there’s no concrete plans laid out to revive Indonesia’s slowing growth and large current account deficit.

To complicate matters, the new Indonesian administration is due to take over in October – the same time QE3 is scheduled to end. The country is one of the ‘fragile five’, a group deemed most vulnerable by the potential outflows of capital once the US Federal Reserve ends its quantitative easing program.

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